Signs That Russia’s Leadership May Be Ready For Tax Reform

The Kremlin is considering a major budgetary move following the presidential election in March 2018. The plan may require some very unpopular measures such as increases in retirement ages and an income tax rate hike. Is Russia’s leadership ready to take a risk?

A long-delayed budget move

The idea of a so-called “budget maneuver” for Russia is not new. In 2011, a group of Russian and foreign academics put together a long-term economic plan known as Strategy-2020 which emphasized investment in human capital and infrastructural development as a method to offset demographic decline and capital depreciation. At the same time, the plan proposed significant cuts of defense expenses and pension system reform. Disagreements over specific measures and new risks, particularly the rising protest activity of 2011-2012, eventually resulted in Strategy-2020 being shelved.

But the proposal survived the following years and currently has a number of high-profile supporters, including the head of Central Bank of Russia Elvira Nabiullina. The idea is also championed by former finance minister Alexei Kudrin, who is considered to be one of the most prominent independent experts with direct access to highest echelons of power in Russia. In 2017, he published a report warning that any further delay of the budget reform will result in long-term stagnation of Russian economy.

When asked about the reports about a possible budget refocus emerging in Russian media in mid-January, Putin’s press secretary Dmitry Peskov stressed that no final decision has been made yet. However, later comments by other major speakers, particularly by the finance minister Anton Siluanov, hinted that this time the government is determined to proceed with the maneuver. The exact way in which it will be implemented is still not entirely clear, though.

A range of options for tax and pension reform

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Siluanov claimed that the funds needed for the maneuver will come from the improved efficiency of the corporate tax collection system. Russia has a long tradition of tax evasion, especially by small and medium enterprises. In 2017, cracking down on those practices allowed the Finance Ministry to recover up to 1 trillion rubles ($17.7 billion) for the state budget. But there is no guarantee that the efficiency of the system remains high in the future. Therefore, other options – which are far less popular – remain on the table.

One possibility is to increase the income tax burden on working Russians. Currently, the tax residents of Russia enjoy a relatively low flat rate of 13 percent compared to other countries with large social security systems. In recent years, several governmental agencies proposed to increase it to 15-17 percent. Alternatively, the government could reduce the ever-growing pressure from state pension system by raising the retirement age. While both options are very risky politically, they constantly feature in public discourse, suggesting that the Russian leadership is preparing the electorate for inevitable change. In particular, President Vladimir Putin himself, during his annual press conference last December, admitted that an eventual retirement age increase is almost unavoidable but promised to execute it mildly.

Several other possible measures involve less of a sacrifice for the general population but still can be politically difficult to implement. For example, Alexei Kudrin proposed to relax the fiscal rule that puts a cap on spending revenues coming from the natural resource trade. According to the current rule, the spending part of the Russian budget receives up to $40 per oil barrel sold while the surplus goes to reserves. Kudrin’s idea to allow re-investment of this oil revenue is not very popular among Russian elites, though. Under the pressure of Western sanctions in 2017, Russia had to finally exhaust its Reserve Fundwhich was built up by saving the surplus from oil trade in early 2000s. As Putin made clear recently, the Kremlin is determined to use the recent new uptick in oil prices to restore its safety cushion with the new surplus.

Finally, the funds for a budget maneuver could come from the reduction of other expenses, particularly those on defense, which have grown steadily in recent years. It would be very unlikely for the Russian leadership to take this route given the ongoing reform of the military sector in Russia and its role in president Putin’s general platform. But at the same time the Russian military often draws attention to its relative efficiency, for example its operation in Syria which is allegedly financed entirely through funds reserved for regular training activities – at least, in its early stage. This allows the Kremlin to be somewhat flexible about potential cuts.

Outlook

The presidential election in March will open a window of opportunity for a possible budget maneuver. Whether the Kremlin would use it will depend a variety of factors, most importantly the outcome of the election. While there are no doubts about the name of the next president, there is a general understanding that the leadership is concerned about a decline in public support for Vladimir Putin. It might manifest itself in low voter turnout, which is likely to become the key metric for the upcoming election.

If implemented, the maneuver will also become a major win for the so called liberal wing of Russian political establishment. The “liberals” took a significant blow at the end of 2017, with former economy minister Alexei Ulyukayev’s harsh sentencing. Ulyukayev supported the budget maneuver while in office. The verdict in his corruption case was widely interpreted as evidence of the conservatives solidifying their influence in the Kremlin. But proceeding with a reform that significant would show that the country’s leadership remains above elite infighting.

Yaroslav Makarov is a candidate for a master’s in international affairs at University of California, San Diego, and is a fellow at the Laboratory on International Law and Regulation. As originally appears https://globalriskinsights.com/2018/02/election-president-russia-budget-tax-refrom/